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Asia Currency Sell-Off Goes From Bad to Ugly

Asian currencies have been battered lately by talk of the U.S. Federal tapering its massive stimulus program and analysts expect the pummeling to continue as other major drivers that led the currencies to appreciate now face pressure.

On top of funds flowing out of Asia on worries about the Fed unwinding its asset-purchase program, Citi Research expects sovereign risk re-assessment, weakness in the Japanese yen , and deteriorating current-account deficits to weaken regional currencies further in the months ahead.

"We think there is more weakness to come for most currencies as some of the major drivers of Asia FX (forex) appreciation since the global financial crisis are less supportive," Johanna Chua, chief Asia economist at Citi said in a report.

Emerging Asian currencies gained in appeal after the global financial crisis (GFC) in 2008 because their countries had favorable financial positions that led to credit ratings upgrades. That stood out in contrast to ratings downgrades in Europe, Japan and the U.S.

But that positive sovereign risk backdrop in Asia has now run its course, according to Citi.

"Many of the big rating upgrade stories in Asia have already happened...while the worries about the financial imbalances from the post-GFC credit-fueled investment boom in China are now weighing on sovereign risk assessments," Chua said.

Concerns about a liquidity crunch in China are growing after an unsuccessful bond auction last week and a spike in interbank lending rates.

"Meanwhile, tail risks that would have been very damaging to some advanced economies, for example a "Grexit" or U.S. "fiscal cliff" have abated," she said, referring to concerns about a Greek exit from the euro zone and U.S. fiscal woes.

Most Vulnerable

Asian currencies that look the most vulnerable now that hot money is flowing out of the region belong to those countries which run a current account deficit, so that includes the Indian rupee, the Indonesian rupiah and Australian dollar, says Richard Yetsenga, head of global markets research at ANZ.

"The question is do they look attractive enough to fund a [current account] deficit that is large? At the moment Indonesia doesn't, India doesn't and Australia doesn't," Yetsenga told CNBC.

The Indian rupee (Exchange:INR=) hit a record low at about 58.98 per dollar last Tuesday and ended Friday with a sixth straight weekly fall.

The Australian dollar (Exchange:AUD=) has fallen nearly 10 percent from this year's high of about $1.059, while Indonesia's central bank surprised markets with an interest rate hike last week to stem the fall of a depreciating rupiah, which hit a four-year low against the dollar on Thursday.

"Any peripheral assets that have deteriorating fundamentals which markets have ignored, any markets that got an access of capital inflow particularly into the bond market, and most of Asia is probably subject to that, and any market which became very expensive [will be impacted]," Yetsenga said.

He added that the Philippine peso was one example of an Asian currency that investors were no longer willing to pay a premium to hold.

The peso (Exchange:PHP=) last week hit a one-year low of about 43.30 against the dollar, down almost seven percent from multi-year peaks hit just a few months ago.

"Investors in the core countries really wanted to buy insurance like buying peripheral assets that were quite expensive, they're just not willing to pay up for that insurance anymore," Yetsenga said.

- By CNBC.com's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu